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Our economic times: Japan joins global easing

History was made earlier this month when the Bank of Japan announced the world’s largest scale of monetary stimulus.

International officials from the G20 and IMF have hailed the actions of Japanese Prime Minister Shinzo Abe and his recently appointed central bank governor Haruhiko Kuroda for making great strides to end Japan’s “lost decade” of deflationary woes.

Japan now joins the ranks of the Federal Reserve and Bank of England in adopting measures of quantitative easing: A record $1.4 trillion of additional monetary base will be added within the next two years, an amount exceeding any country as a percent of GDP.

The bank governor is committing Japan to a U.S.-like open ended bond purchase program in which the central bank’s balance sheet and the maturities of its securities will both double. Real estate investment trusts and exchange traded funds will also join the portfolio.

After almost two decades of deflationary pressures and economic stagnation in Japan, the country’s leaders hope the unprecedented scope of monetary policy will ignite economic activity.

This may be achieved in at least two ways.

First, by adopting an inflation target of 2 percent within two years, Japan is seeking to achieve an environment of increased inflation expectations. If successful, market participants may view their purchasing power to be greatest now relative to the future and increase consumer spending.

The second channel of stimulus from pursuing a competitive devaluation occurs through international trade in goods and services. A foreign exchange market flooded with Japanese currency (yen) weakens its value against competing currencies like the dollar.

Indeed, the Yen slid to a four-year low against the dollar after the policy announcement and has depreciated against 16 major currencies over the last week.

U.S. and other G20 finance ministers prepare to meet in Washington this week to discuss the ramifications from the yen’s rapid decline and the potential for triggering a currency war at a time of weak global growth.

Although cheaper exports for domestic companies such as Toyota, Honda, and Sony would imply a global economic advantage, Japan relies heavily on intra-regional commerce and international trade tends to be a zero sum game.

Skeptics of the policy feel that Japan’s most influential trading partners such as South Korea and Australia may already be showing signs of economic headwinds from lost export market share in industries such as those for automobiles.

Competitors will face the question of whether to chase regional goods prices downward to align more closely with cheaper Japanese exports or seek other production, supply chain and industry options.

This bold policy move comes at a time when Japan suffers from a debt overhang of more than 200 percent of GDP. Investors have supported bond markets, however, with ten-year yields trading at three-quarters of one percent.

Additionally, the debt scenario will be aided by the newly announced inflation target as the real burden of government debt will be diminished.

One area of concern in Japan’s pursuit of unprecedented monetary stimulus lies with how inflationary the monetary easing will become.

The answer may lie with how far away Japan’s production is from potential economic output, a situation where most resources would be employed.

With an unemployment rate hovering around four percent, an aging population and low population growth, Japan may be closer to using more of its resources than a country with higher unemployment and more economic slack in the system such as the U.S.

If Japan is already operating near its production capacity, prices may be pressured to rise. Recall, however, that monetary easing entails a central bank increasing its reserve accounts with banks and other financial intermediaries. It is ultimately up to these institutions to inject the additional reserves into circulation in the form of loans.

Most economists understand that growth in the developed world has stagnated relative to that of the emerging economies.

Long-term unemployment remains a major threat to future prosperity.

By taking such stimulative measures, countries like the U.S., Japan and Britain have displayed a commitment to stand on guard against prolonged economic challenges even if it entails joining the new wave of unprecedented monetary stimulus.

Dr. Nicholas J. Mangee is assistant professor of economics at Armstrong Atlantic State University and can be reached at Nicholas.mangee@armstrong.edu.